What is the Meaning of Capitalization?

Capitalization refers to the amount of capital required by a business enterprise. Capital can be obtained in the following ways:

Therefore, capitalization is the sum total of the funds received through shares, bonds, loans, and retained earnings. In other words, the sum total of fixed capital and working capital forms capitalization.

Definitions of Capitalization

Some notable definitions of the term capitalization are stated and discussed below.

1. A. S. Dewing: “The term capitalization or the valuation of capital includes the capital stock and debt.”
2. Gestenbergh: “For all practical purposes, capitalization means the total accounting value of all the capital regularly employed in the business.”

When determining the capital of a company, the promoter must consider the cost of fixed assets, as well as the cost of establishing, organizing, and running the business, working capital, and sufficient funds to meet contingency demand.

The term capitalization is closely associated with the earning capacity of an enterprise. Both overcapitalization and undercapitalization are dangerous for organizations. A stage of optimum capitalization is the desired goal of every enterprise.

This is the stage where the company earns a fairly good return.

In a nutshell, these definitions indicate that capitalization refers to all the long-term funds raised through issuing shares, debentures, and loans from specialized financial institutions.

Example

Suppose that a company has the following information on the liabilities side of its balance sheet:

$
Equity share capital 4,000,000
Preference share capital 1,000,000
Debentures 2,000,000
Loan from IBRD 2,500,000
Loan from IFC 1,500,000
Creditors 500,000
Outstanding 20,000

Capitalization, in this case, amounts to the sum total of long-term funds. These are:

  • Equity share capital
  • Preference share capital
  • Debentures
  • Loans from IBRD and IFC

Now, it’s clearly seen that capitalization—in a broader sense—refers to the process of determining the plan or patterns of financing.

In a narrower sense, capitalization is the sum total of all long-term securities issued by a company and the surpluses not meant for distribution.

It should also be noted that the term capitalization is used only for companies and not for sole proprietorships. Capitalization is capital plus long-term loans and retained earnings.

True is a Certified Educator in Personal Finance (CEPF®), contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

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